BECOME AN INFORMED INVESTOR
EDUCATIONAL MATERIAL
NECESSARY INFORMATION FOR INVESTING IN CROWDFUNDING OFFERINGS
Regulation Crowdfunding
In accordance with Regulation Crowdfunding (Section 4(a)(6) of the Securities Act), educational materials must be provided by the platform. Potential investors must confirm they have received and understand the educational material. The material covers important elements of crowdfunding. The information is necessary for investors to determine if the investment opportunity is suited to their interest. The education material should be studied by individual investors to confirm understanding.
Purchasing Process
To begin the investment process, an account needs to be set up. Information including your name, your state of residence, and consent of electronic delivery of materials must be given. The investor will then select an investment opportunity and complete the checkout process. Contributed fund will be sent to the escrow until the funding process is complete. Once completed, the escrow will send the funds to the issuer if the campaign hit its goal. If not, the capital will be sent back to the investor. When the issuer receives funds, investors will receive a “paper wallet”, or information on how to access their smart contract token. The smart contract will contain the proof of ownership. It will service the bond for the duration of the contract by calculating payments and distributing money.
Security Types
Token Interest specializes in small business bonds. Businesses featured on the platform undergo a due diligence process. Investors should be aware of risks before determining to invest in these instruments. Bond instruments have specific risks they face. Additionally, due to the nature of small businesses, bonds featured on this platform are riskier than bonds offered on the open market. Below is a non-exhaustive list specific to instruments featured on the platform:
Bonds Risks:
Interest Rate Risk: Interest rate risk is the risk of interest rates rising after the purchase of the security. If interest rates rise, the security would become less valuable because potential purchasers could obtain a bonds with higher returns. The securities would depreciate in value and resell may be more difficult.
Inflation Risk: Bonds are considered highly vulnerable to inflation. Inflation risk is the possibility that inflation rises higher than expected. Investors normally expect a small level of inflation. They calculate this level of inflation into their expected return. If inflation expectation are around 2% and the purchased bond supposed to return 8% then investors would expect an actual return of 6%. When inflation rises past expected values, the return on the investment decreases.
Bond Service Risk: Bonds service risk highlights the investors’ reliance on the bond servicer. In most situations, the investor is reliant on the continuation of the serving company to receive their payments. In the event of default other loan servicers can be used, but changing servicers adds additional costs to the process. Token Interest relies on smart contracts to service loans. This means the loan servicing process has been automated. Although it is beneficial that the investor does not have to rely on the continuation of a serving company, there are other risks associated with smart contract servicing the loan. As with all software entities, smart contracts pose risks of being hacked. Additionally, smart contracts are not thoroughly scrutinized by the court of law.
Voting Power Dilution: In the unlikely event that debt security offers a form of voting power, there is a possibility of dilution of voting power as the company grows. This could take place for a variety of reasons including owners exercising stock options.
Liquidation Risk: In the event of default, the company’s assets will be sold to satisfy debts. Companies may have existing debt that take priority over issued securities during liquidation. If this occurs, those debts would need to be satisfied before capital is issued.
Crowdfunding Risks
There are several risks that all securities sold through Regulation Crowdfunding face. Many of those risks are listed below. This list is not exhaustive and potential investors should consider all risks when deciding to invest.
Limited Overview: Securities sold through Regulation Crowdfunding rely on an exemption from federal and state registration. This means that they are not reviewed directly by a government agency. Governmental review can help provide reliability. Less review may mean securities are more vulnerable to misinformation.
Resale Risk: No central secondary exchange currently exists for securities sold under Regulation Crowdfunding. This means that resale of security could be difficult. Investors may need to find their owner purchaser or hold the security for the entire duration.
Default Risk: All companies face the risks of default, but small businesses have higher rates of default than larger businesses. They are untested in certain economic and market conditions and have fewer resource to tap during difficulties. Investors should be able to financially cope if the bond loses all value.
Limited Information: Some issuer may not be required to give continual updates as explained below. Investors may have limited information in the future on how the company is doing. This could make resale more difficult.
Inaccurate Information: Financials and valuations from smaller companies have limitations and may contain inaccuracies. Because of this, small businesses feature on the platform may have inaccuracies. Evaluating these investment opportunity are more difficult.
Industry Specific Risk: All businesses are subject to industry specific risk. Changes in the industry could result in unforeseen problems and decreased profitability. This may limit the company’s ability to pay obligations, including this bond.
Misuse of Funds Risk: Monitoring invested capital may prove difficult and therefore issuers may not use funds as promoted. This action may increase the risk of the bond which would lead to higher levels of default.
Fraud Risk: Although Token Interest is required to execute a due diligence, the possibility of fraud remains. The possibility exists at all level of investing. Investors should be appropriately cautious.
Investing Limitations
The Security Exchange Commission has limited the amount of capital individuals may invest in Regulation Crowdfunding securities during a 12 month period. Investors with an annual income or net worth of up to $124,000 may invest $2,500 or 5% of their net worth or annual income, whichever is greater, during a 12 month period. For investors with a net worth and annual income over $124,000, they may invest 10% of their net worth or annual income, whichever is greater. However, they may not investment more than $124,000 during a 12 month period. Accredited investors have no limitation on the amount of capital they may invest. Click here to see the table from the SEC website for clarification.
*Net worth is defined as total assets minus total liabilities. For purposes of crowdfunding, net worth calculations cannot include the value of your primary residence.
Cancellation Limitations
The investor is allowed to cancel their commitment for any reason if it is done at least 48 hours prior to the close of the funding period. If canceled, the investor will receive a refund. Once the investment is within 48 hours of the close, investors cannot, for any reason, withdraw their funds. This includes those who invested during the last 48 hours of the funding period. If the issuer reaches its target early, it may close early. They must inform investors five days in advance. If the issuer has a material change of information, investors must reconfirm their commitment otherwise their fund will be returned.
Resale Restrictions
Securities sold in on this platform have limitations on resale. During the first year after the purchase, investors may only resale securities to accredited investors (as defined by rule 501 of regulation D), to the issuer, in an offering registered with the commission, or to a family member. After the first year, the investor may sell the security to anyone. However, there is no central location for resale and willing buyers may be limited. Investors should expect to hold their security to maturity or find their own buyer.
Continuation of Relationship
Purchasing a security from this platform does not guarantee a continued relationship between the platform and the issuer or purchaser. The platform may or may not cease operating. The purchaser should intend to communicate directly to the issuer after the investment process is completed.
Annual Report Requirements
Financial disclosure requirements vary depending on the amount of capital raised. The more a firm raises, the more disclosure is required. Below are the requirement for different levels of capital raised.
$124,000 or less: If outstanding capital raised through crowdfunding plus current capital raised is less than or equal to $107,000 then information from the most recent tax return should be posted. This information must be certified by the principal executive officer. If the company has financial statements available, those must be provided instead of the tax return information.
Between $124,000.01 to $618,000: If outstanding capital plus current capital raised is between $124,000 and $618,000, the company must provide financial statements reviewed by a CPA. If audited financial statements are available, these must be provided instead.
Between $618,000.01 to $5 million: When gross capital raised is above $618,000, companies must provide audited financial statements. If this is the company’s first time funding through Regulation crowdfunding, financial statements are only required to be audited if raising above $1,235,000.
Financial statements are posted to the SEC’s website and the platform. They are available for investor review during the funding period.
Continued disclosure of financial information from the issuer is not guaranteed. In the following situations the issuer may cease future financial disclosure:
- If the issuer has filed at least one annual report and has fewer that 300 holders of record.
- If the issuer has filed at least three annual reports and total assets do not exceed $10,000,000.
- If the issuer liquidates in accordance with state laws
- If the issuer or a third party repurchases the securities.
- If the issuer becomes a reporting company required to file reports in reliance on Exchange Act Section 13(a) or 15(d).
Considerations
Due to the risk associated with investing, investors should consider if these investments are right for them. Investments inherently have risk. Fraud or default are possible. Investors must be able to financially cope if all of the bond loses all value.
Token Interest is considered a funding portal by the SEC and is intended to bring together issuers and purchasers of securities. Token Interest is not a financial adviser and will not give financial advice. Securities purchased on the platform are not guaranteed. Token Interest may only receive securities as an in kind payment for services performed. Compensation cannot be given for information on investor referrals.
Learn More
Learn more about crowdfunding by reading the SEC’s final rule here. Other good resources are SEC Investor Alerts and Bulletin and Investor.gov.